Ups and downs are part of the stock market cycle. An upward-going market usually pleases most investors. But, whenever investors hear about a stock market correction, they often think of it as a bear market and start worrying. But should investors worry about stock market corrections? The article answers this question.
This article covers what a stock market correction is, reasons for a stock market correction, how to identify and prepare for a stock market correction and a list of past corrections in the Indian stock market.
What Is A Stock Market Correction?
Correction means a gradual fall of 10% or more (but usually less than 20%) in any financial asset, like a stock, bond, currency, etc., from its 52-week high. When such corrections happen in major market indices or the market as a whole, they are referred to as stock market corrections.
Why Do Share Market Corrections Happen?
There can be several reasons for a stock market correction, and a few of them are the following.
Investor sentiments have always affected the way the market moves. If investors fear and believe that the market will fall soon (because of news, rumours, or other reasons), they may sell stocks in a panic. Lower demand and higher supply may lead stock prices to fall.
In unexpected events like pandemics, wars, attacks, oil-supply shocks, etc., the stock market may see a temporary fall as investors may be sceptical about the companies’ earnings or the effects of such events on the economy.
Overheated stock market
In a bull market, stock prices and values of market indices keep increasing, motivating investors to buy stocks with expectations to sell them later at higher prices. After a point when stock prices inflate and reach certain levels, investors start selling stocks to enjoy gains.
When selling pressure exceeds buying pressure, the stock market may suffer from correction, and the stock prices may reach the original level.
How To Identify Stock Market Correction?
Firstly, identifying stock market corrections is quite challenging. Here are some ways which may help to do so.
- Candlestick charts, hollow candles, volume candles, etc., may help to assess stock price movements and, thus, probable market corrections.
- Technical tools like the relative strength index (RSI), stochastic oscillators, fear and greed index, etc., may help to identify market correction.
- The market correction may be next in line if there is a bull market.
However, nothing can certainly predict or identify stock market corrections because several reasons could lead to them.
What Factors To Consider While Correction Happens?
Stock market corrections are for the short term
Though there is no definite period for which the stock market corrections can last, they usually last for a few weeks or months. Plus, not all stock market corrections turn into a bear market.
Stock market corrections are unavpidable
Market corrections are part of the stock market cycle and happen frequently. An investor cannot do anything to prevent them from happening. The stock market indices reflect economic conditions, so in unfavourable economic conditions, the stock market may suffer from corrections.
An ideal time for buying value stocks
Stock market correction may allow investors to buy their favourite value stocks at a relatively low price. Once the market correction phase ends, investors are likely to earn good returns from the jumped stock prices.
How Can You Prepare For A Correction?
1. Go for diversification
Diversification means distributing investments across various asset classes or securities, and diversification can reduce the overall investment risk. An investor who invested in multiple securities, such as stocks, gold, bonds, etc., may see a lesser adverse impact of a market correction on his/her portfolio than one who only invested in stocks.
One may consider his/her risk tolerance level and expected returns and go for asset allocation accordingly.
2. Resist the urge to sell in panic
Falling stock prices may create anxiety and urge investors to sell the stock before it falls further. But, market corrections may be more significant for traders than long-term investors, and the market usually recovers over time. Therefore, it is essential to think patiently before making any move.
3. Review and rebalance the portfolio
Based on one’s financial conditions, his/her risk tolerance level may change. So, it is vital to reevaluate one’s risk profile periodically. Another essential thing is to review investments and make adjustments (purchasing or selling holdings), if required, to keep them in line with investment objectives.
List Of Past Stock Market Corrections
Here are a few examples of past stock market corrections in India.
|Started in||Probable reasons|
|February 2022||Russia-Ukraine tension|
|February 2020||COVID-19 pandemic|
|February 2016||Higher number of non-performing assets of Indian banks and other global factors|
|August 2015||Slowdown in China|
|January 2008||Housing bubble|
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Market corrections are part of the stock market cycle and often occur during or after the bull market. However, there is no exact answer to how often and how many times a year they occur.
Being patient and not getting into panicked selling during market corrections might help long-term investors. One may also consider buying fundamentally sound stocks during a market correction if those stocks are trading at a discount.
Historically, some market corrections lasted for weeks, some for a few months, and one (which happened in 2007-2008) even lasted more than a year. So, there is no definite period for which the market correction can last.
The NIFTY 50 and SENSEX fell by more than 10% from their recent high in February,2022 after Russia announced military operations in Ukraine. At the time of writing, this was the last stock market correction.
Stock market corrections suggest declining stock prices. But, a good thing about the stock market correction is that it may bring artificially inflated stock prices down to their actual levels and allow investors to buy their favourite stocks at relatively lower or fair prices.
A stock market crash is a sudden and significant decline in most stock prices. In contrast, a gradual price drop between 10% to 20% suggests a stock market correction.